Will Accidental Landlords Hold ‘em or Fold ‘em?

The vast majority of people who are considered real estate investors by the Census Bureau don’t think of themselves as real estate investors at all. They are just normal working people who happened to end up owning a home or two that they rent out.

They are called “accidental investors.” They never intended to get into real estate investing, but circumstances mandated it. Some had to move during the housing depression and rather than take a loss on their homes they rented the old one to make enough to pay for the mortgage, taxes and maintenance. Others inherited a property or saw a good deal down the street. Some were underwater and got tired of seeing no return in equity for their monthly payments so they moved into a less expensive rental and rented out the home they owned to cover the mortgage.

Then the scales lifted from their eyes. They did the math and realized that as long as they managed their property successfully they were going to make month at a return on investment that’s hard to beat.

There are many more accidental investors than intentional ones. About 9 percent of the adults surveyed in the BiggerPockets.com/ Memphis Invest investors’ survey last August fit the definition: they own investment property but don’t consider themselves to be investors. Forbes just published a very good piece how the pros and cons that’s unfortunately about five years too late for most accidental landlords. A 2011 survey of investors by Move, Inc. only 36.5 percent had experience in more than one property transaction.

As prices rise, especially for moderate to lower priced housing, an expectation is growing in the traditional, homeowner-oriented real estate community that these accidental investors will cash in their rentals. The thinking is that accidental investors never wanted to get into real estate in the first place, so they’ll leave at the first opportunity.

NAR economist Ken Fears makes the case in a May 28th commentary on Realtor.org, “Accidental Landlords Could Boost Inventories.” Ken sees in accidental investors a convenient solution to the inventory shortage which is stifling sales but is also, after all, the primary motivator of the housing recovery.

“Between April of 2006 and April of 2011, the median home price fell 27.6%. However, the median price rebounded 19.7% over the subsequent two years. While many formerly underwater homeowners are just now getting their first shot at taking advantage of record affordability, others who opted to rent their properties will now be able to sell them, releasing much needed inventory to the market,” he suggests.

Fears points out that the month’s supply of homes for sale reached a 9-year low in March of 4.3 months, well below the 6.5 months typical of a balance market. This figure rose to 5.2 months in April with the normal seasonal increase, but was still 21.2% below the figure from a year earlier. “While tight inventories can drive price growth, excessively stringent supplies can create headwinds to demand as consumers are priced out of the market or left with inadequate options,” he wrote.

“At the peak, roughly 12.1 million homeowners were underwater on their mortgages owing more than their property was worth…Not all underwater homeowners were equity constrained, though. Some owners were able to rent their original properties and put together enough money for another home purchase. What’s more, the expansion of availability of the FHA’s low down payment program helped facilitate this process, enabling mobility and fluidity in the market for these accidental landlords.”

Underwater homebuyers?

Wait a minute. Buying a new home takes 5% in closing costs, a 3.5% FHA down payment, a FICO score around 740, a front end debt-to-income ratio of 28, monthly payments that include FHA’s upfront and monthly mortgage insurance premiums and moving costs. Say on a low cost $175,000 home that’s $20,000 up front. Fixing up the old house, advertising and missing at least one month’s rent when moving is going to cost another $5,000. If you’re underwater and have $25,000 laying around, wouldn’t it be smarter to pay down your principle so that you aren’t underwater anymore? Plus, like any investor, they’ll have to switch their mortgage from residential to commercial, which certainly will result in a higher rate of interest and might not be possible if they are underwater.

Chances are that there aren’t many home owning accidental landlords out there, though perhaps quite a few renters. Along with the several million accidental landlords who became investors because they couldn’t sell a house, the question is are they getting ready to sell now that prices are rising?

But the larger question is more important.

“Although rents are strong and opportunities like HARP exist for accidental landlords to refinance at record low mortgage rates, not all owners are cut out to be landlords or they may have more productive uses for their equity. For instance, an owner with an FHA mortgage might want to buy down principle on their primary property in order to avoid the hefty mortgage insurance on FHA mortgages. Regardless, many owners of rental properties will now have the opportunity to unwind this position, bringing new inventory to the market that would be a welcome addition to current supplies,” said Fears.

Certainly a lot of underwater folks were not cut out to be landlords, which is one reason short sales are so popular. It’s also a little unusual for an NAR guy to assert in print that homeowners would have more productive uses for their equity than owning a home, though it’s true for those owning homes during the crash. But if prices are still far from what you paid and they are still going up. And if someone is sending you a rent check that pays the mortgage plus, what’s the hurry?

Property values have more room to rise and so do rents. Reis just reported rents rose .5% in the first quarter and I just received a rental survey of real estate investors, real estate agents and accidental landlords that found 60% of those surveyed see rents rising over the next 12 months. Higher rents, the survey results show, will be accompanied by increased demand on the part of tenants, as roughly 71% of the respondents said that when their properties do become available, three or more prospective tenants will typically compete for the lease.

Since you’d have to crazy to sell right now, chances are a flood of properties from accidental investors is not in the works. After all, most people DO learn from their mistakes.